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This is the second of three chapters on macroeconomic measurement. This chapter focuses on how economists measure the aggregate price level and the inflation rate, how these measures are applied to adjust dollar amounts to eliminate the effects of inflation, and how inflation and interest rates are related. | Inflation and the Price Level Chapter 16 McGraw-Hill/Irwin Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved. Learning Objectives Explain how the consumer price index (CPI) is constructed and use it to calculate the inflation rate Show how the CPI is used to adjust dollar amounts to eliminate the effects of inflation Discuss the two most important biases in the CPI Distinguish between inflation and relative price changes to find the true costs of inflation Summarize the connections among inflation, nominal interest rates, and real interest rates Keeping up with Grandpa Prices of goods change over time Adjust values, incomes, or spending for change in prices Constant purchasing power Baseball salaries Bruce Lee earned US$500,000 in 1973 Jackie Chan earned US$15 million in 2007 Inflation increases uncertainty when planning for the future Consider costs of inflation 3 Measuring the Price Level The Consumer Price Index (CPI) is a measure of the cost of living during a | Inflation and the Price Level Chapter 16 McGraw-Hill/Irwin Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved. Learning Objectives Explain how the consumer price index (CPI) is constructed and use it to calculate the inflation rate Show how the CPI is used to adjust dollar amounts to eliminate the effects of inflation Discuss the two most important biases in the CPI Distinguish between inflation and relative price changes to find the true costs of inflation Summarize the connections among inflation, nominal interest rates, and real interest rates Keeping up with Grandpa Prices of goods change over time Adjust values, incomes, or spending for change in prices Constant purchasing power Baseball salaries Bruce Lee earned US$500,000 in 1973 Jackie Chan earned US$15 million in 2007 Inflation increases uncertainty when planning for the future Consider costs of inflation 3 Measuring the Price Level The Consumer Price Index (CPI) is a measure of the cost of living during a particular period The CPI measures The cost of a standard basket of goods and services in a given year relative to the cost of the same basket of goods and services in the base year Base year for the CPI changes periodically, normally it changes every five years Calculating the CPI 2013 Spending Monthly Cost in 2013 Rent (2 bedroom apartment) $500 Hamburgers (60 at $2 each) 120 Movie tickets (10 at $6 each) 60 Monthly expenditures $680 2018 Spending Monthly Cost in 2018 Rent (2 bedroom apartment) $630 Hamburgers (60 at $2.50 each) 150 Movie tickets (10 at $7 each) 70 Monthly expenditures $850 Calculating the CPI CPI is the ratio of the cost of the basket of goods in the current year to the cost in the base year Base year cost $680 2018 cost $850 CPI = (850 / 680) (100) = 1.25 Cost of living in 2018 is 25% higher than in 2013 CPI for the base year is always 1 CPI for a given period is the cost of living in that period relative to what it was in the base year Statistical authorities .
